We initiate coverage on Balkrishna Industries (BKT) with BUY, valuing the stock at 20x Sep’19E EPS and target price of Rs 2,062 per share, implying a target FCF yield of 5.0% on Sep19E. We expect cyclical improvement in the global Off-Highway Tyre (OHT) segment and believe BKT is well-placed to gain market share in both Agri and Off-the-Road (OTR) segments in North America/Europe. Conversion cost advantage, India labour cost arbitrage versus competitors and product mix shift towards OTRs could ensure high margin stability, ~30%. Large SKU library is the key entry barrier in the business and BKT’s over 20 years’ experience in this segment wards off potential competition from other Indian tyre makers. With ample capacity headroom, stable margin profile and subdued commodity prices, we expect BKT to register FY17-20E revenue/EBITDA/PAT CAGR of 14%/15%/14% respectively versus 1%/5%/13% revenue/ EBITDA/ PAT CAGR FY14-17. With its manufacturing base in India, BKT has a highly favourable cost structure with employee costs forming only ~6% of revenue as against 20-25% for the other global players. Thus, despite selling at 15-20% discount to global players, BKT is able to maintain high EBITDA margins.
BKT’s new plant at Bhuj spread over 300 acres has added 140,000 MT/year to its capacity. The plant uses modern equipment for production of steel rings and latest vulcanising presses even for large tyre sizes. The company’s modern R&D centre coupled with an outdoor tyre test-track is set to aid product development efforts for its ever-expanding SKU library. With multi-year drought in key US states likely to end this year, agricultural tyre demand is likely to improve. Rise in commodity prices has spurred mining activity in North America. Coupled with improving construction activity, demand in the OTR segment is also likely to pick up.
Globally ~2/3rd of the specialty tyre market caters to earthmoving and construction segments. However, BKT’s revenue share from this segment is just ~33%. With the new plant now fully ramped-up, BKT is focusing on the mining/construction segments and filling the gaps in its offerings in this space to aid its global market share, ~5% currently. With demand improving in the US markets in both agriculture and non-agriculture segments, new product launches, market share gains and possible demand revival in Europe, we expect improvement in utilisation levels at the Bhuj plant. With no significant capex lined up in the next 2-3 years, we expect strong FCF generation, ~Rs 30 billion over FY18-FY20.